Putin is playing with fire as he looks to starve the West of oil

Joe Biden has been running down the US strategic petroleum reserve at an effective rate of 0.8 mb/d since March. This helped the Democrats avert a wipeout in Congress last month but it has distorted the global market and disguised the underlying lack of supply. It has also depleted the strategic reserve to its lowest level in forty years.

US shale cannot come to the rescue this time. In previous cycles it grew at 1 mb/d a year, enough to break the OPEC stranglehold on the global market. This year it struggled to reach half that level. The best seams in the Permian and Bakken have been exploited. Morgan Stanley said the “expected ultimate recovery” of wells has dropped this year for the first in the history of modern fracking. Rising capital costs are further eroding the business model of frackers.

China’s reopening is likely to have a J-Curve effect on oil as cases spread like wildfire in a ‘naive’ population, leading to self-isolation and jerky stop-go policies. Oil demand could fall this winter before taking off in earnest.

“Road, rail, and air passenger travel in China is still 50-70 per cent below normal levels, which is astonishing. But we don’t think they can risk reopening given the low vaccination rate of the elderly and the lack of ICU beds in hospitals,” said David Fyfe, the IEA’s former oil guru and now chief economist at Argus.

There is a revealing anomaly in the market. The integrated oil and gas sector on the S&P 500 is up by over 60 per cent this year, even though crude is today lower than it was before the invasion of Ukraine.

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This extreme divergence suggests that the big funds are looking through the current cyclical downturn, well aware that there are not enough new fields coming on stream to replace declining wells. Capex investment in oil and gas has fallen from $US1.3 trillion ($1.9 trillion) to $US700 billion since 2014. There will be one last structural supply crunch before electrification prevails in the 2030s.

Putin is a predatory opportunist. He began to ratchet up his gas war in the late summer of 2021 only after it was clear that post-COVID recovery was already tightening the gas market. If he is going to withhold oil, he will do so only once market forces are aligned in his favour.

What is clear is that the West has boxed him in with the price cap. His Sovcomflot fleet of 80 active tankers is too small to export crude from Russian ports in the Baltic and the Black Sea. He has acquired another 50 or so but there are limits. Much of the shadow fleet is composed of giant workhorse VLCC tankers that are too big for Russia’s European ports.

“Russia exports 6 mb/d of crude and products by sea, and 80 per cent of this goes out of its western ports. The system was designed to supply Europe. Only 20 per cent of his seaborne exports go through the Pacific,” he said.

This creates a logistics nightmare. Instead of a six-day round trip to Hamburg, his tankers face a 90-day round trip to China, even if they can obtain recognised insurance. That uses more fuel, raises costs by $US12 a barrel, and locks up ships for longer.

“Oil is the only thing that he has left. He has destroyed the rest of the economy.”

White House energy coordinator Amos Hochstein

The West is banking that Putin will be forced to go along with the G7 price cap, designed to keep oil flowing while eroding his income. It assumes that he will not risk crippling his network of 130,000 oil wells by shutting them down. Only a fifth have strong enough pressure to throttle back output for a sustained period without damaging the field.

Yet Putin has already shown that he is willing to sacrifice his gas industry and shatter relations with the West, all for an anachronistic imperial land-grab. If he hesitates, it is because an oil crisis would risk a rupture with China and India. “It is the last roll of the dice. What’s left if he alienates all buyers of his energy?” said Fyfe from Argus. Or it is because even Putin’s appetite for gambling has limits.

“Oil is the only thing that he has left. He has destroyed the rest of the economy,” says White House energy coordinator Amos Hochstein.

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I do not wish to criticise the G7 price cap. It is a justifiable calculus. There is a fair chance that Putin will be ground down by the West’s overwhelming economic and geopolitical power. But he may equally defy the G7 and let rocketing oil prices talk for him.

Telegraph, London

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